An Important Reminder for Property Purchases through your Self-Managed Superannuation Fund

If you are considering purchasing a property through your self-managed superannuation fund (‘SMSF’), it is essential that prior to entering into any contract of sale you determine whether you need to put in place a custodian arrangement. In this article we provide a brief overview of the Limited Recourse Borrowing Arrangements for SMSFs contained in the Superannuation Industry (Supervision) Act 1993 (‘the Act’).

If you are considering acquiring real property in your SMSF, we urge you to contact us to discuss the purchase terms before you take any steps.

What constitutes a Limited Recourse Borrowing Arrangement?

As a general rule, trustees of a SMSF are prohibited from borrowing money. Pursuant to section 67A of the Act trustees of a SMSF may only borrow money from a lender to fund the acquisition of an asset in certain circumstances.

In order to comply with the Act, the acquisition of an asset by a regulated superannuation fund via a borrowing must comply with the following criteria:

1. the loan proceeds are used to acquire a single asset only which the trustee of the SMSF is not otherwise prohibited from acquiring.

This not only includes the purchase price under the contract of sale but also the expenses incurred in connection with the acquisition (such as loan establishment costs, legal costs and stamp duty) and expenses incurred in maintaining or repairing the asset to ensure its financial value is not diminished.

2. the loan proceeds are not applied to improving the acquired asset.

This means that a trustee of a SMSF cannot enter into a Limited Recourse Borrowing Arrangement to purchase a single asset if that asset is:

a.   vacant land and you intend to use part of the loan proceeds to build a residential property on the land;

b.   vacant land and you intend to use money accumulated in the SMSF to build a residential property on the land;

c.   a property made up of a dwelling and land and you intend to use part of the loan proceeds to demolish the existing dwelling and build a new dwelling on the land;

d.   a property made up of a dwelling and land and you intend to use money accumulated in the SMSF to demolish the existing dwelling and build a new dwelling on the land.

If the trustee of a SMSF wishes to improve the property (i.e. through developing, demolishing, rezoning or building) then the loan must be repaid in full prior to the improvements being commenced.

3. the acquired asset must be held on trust for the trustee of the SMSF by a separate entity, so that the trustee of the SMSF holds the beneficial entitlement to the asset.

This is where the trustee of the SMSF will need to ensure that it has a separate entity which agrees to enter into a custodian arrangement. The crux of the arrangement is that the separate entity will hold the legal title to the asset but the trustee of the SMSF will hold the full beneficial interest to the asset.

The separate entity is often referred to as a ‘custodian trustee’ or a ‘bare trustee’. To ensure that the requirements of section 67A of the Act are met, it is crucial to ensure that all relevant documents to evidence the custodian arrangement have been prepared correctly and duly executed. These documents can include:

a.    a resolution of the trustee of the SMSF;

b.    a resolution of the custodian trustee; and

c.    a Custodian Trust Deed (or Bare Trust Deed).

The custodian documents need to pre-date any contract of sale as the Buyer entity must be the custodian trustee.

4. the trustee of the SMSF must have the right to acquire legal ownership of the asset from the separate entity by making one or more payments after obtaining the beneficial entitlement to the asset.

If the custodian arrangement is correctly recorded, the custodian trustee will act on the direction of the trustee of the SMSF at all times and will also transfer the legal title to the trustee of the SMSF on request.

Once the loan proceeds have been repaid in full, the trustee of the SMSF can be recorded on title of the property as the legal owner.

5. the loan to the trustee of the SMSF must be limited recourse in nature, so that the lender’s rights to recourse on default of the loan are limited to rights to the asset being acquired.

This is to ensure that the lender only has a right of recourse against the property purchased and not any other asset of the SMSF. This limitation promotes the overall principle that superannuation funds are for retirement purposes and must be reasonably protected.

It is important to ensure that any loan documents are to the trustee of the SMSF as that is the entity that is borrowing the funds from the lender.

6. the asset is not subject to a charge other than as provided in respect of the borrowing by the trustee of the SMSF

What is the purpose of the Limited Recourse Borrowing Arrangements?

The superannuation legislation was amended in respect of limited recourse borrowing arrangements so that:

• superannuation fund assets are better protected in the event of a default on a borrowing;
• the asset within the arrangement can only be replaced by a different asset in very limited circumstances specified in the Act;
• superannuation fund trustees cannot borrow to improve an asset;
• the borrowing is permitted only over a single asset or a collection of identical assets that have the same market value; and
• the recourse of the lender or of any other person against the superannuation fund trustee for default on the borrowing is limited to rights relating to the acquirable asset.

What are the repercussions of not complying?

If the required conditions of the limited recourse borrowing arrangements are not satisfied, borrowing money under the arrangement will result in a contravention of one or more of the superannuation rules under the Act. A contravention may have civil or criminal consequences.

Practically, a lender may not agree to provide the trustee of the SMSF with a loan which would likely result in any contract of sale being terminated and the consequences of such termination will need to be dealt with. Alternatively, a trustee of the SMSF may be required to sell the acquired asset which could result in a substantial loss.

How can JHK Legal help?

Please contact us as soon as possible if you are considering a purchase through your SMSF. We can provide advice as to the limited recourse borrowing arrangements rules and all other requirements under the Act and also prepare the necessary custodian documentation.

We also assist clients with establishing their self-managed superannuation funds so please reach out if you are wanting to set up your own SMSF.

In addition, our conveyancing subsidiary MKP Property Lawyers, can provide their excellent services to act in the purchase of the property from the initial contract review up until settlement has been effected. Please do not hesitate to give us a call to discuss further!

Written by, Simone Wilson, Senior Associate